Today, 33 states allow the legal use of marijuana. States like Colorado expect to rake in $100 million by 2024, and California, the largest regulated cannabis market, has an estimated net worth of $8.5 billion. The cash is real. However, to make the most out of the Green Rush, some cannabis accounting will come in handy.
Every prospective investor should answer the question: Should I grow and sell my product or separate cannabis growth and dispensary services into separate businesses?
The structure of your cannabis business is vital once you settle on Vertical Integration (growing and selling the product yourself). The arrangement can put you in place to minimize taxes and reap other benefits or put you at a disadvantage. So, is separating growth and dispensary services wise?
The Case Against Separation
The Tax Problem
Separating growth and retailing makes your business a multi-entity. Multi-entity tax benefits can result, but they are sometimes not guaranteed. They depend on whether a cannabis accountant has applied tax laws well.
Since cannabis businesses have to pay taxes on gross profits due to 280e, structuring an S-corps may appear beneficial from a tax point of view. S-corps have the option of passing income to shareholders to evade double taxation.
However, courts get strict when cannabis businesses try minimizing tax through multi-entities. The two entities must be as separate as having different owners or managers to reap the tax benefit. Thus, separation may spill over to new management.
The key takeaway is that separating the business into growth and dispensary may result in minimal taxes. However, mitigating taxes will require an experienced cannabis accountant who understands how to apply the 280e strategy, Section 471-3, and 471-11 to benefit the cultivator and the seller. Improper application can be very costly for the firm.
The Insurance Issue
Even as a single entity, insuring a cannabis business is unique. While cannabis is legal at the state level, federal law treats it as an illegal substance. Federal criminal law binds insurance companies. This issue, coupled with the fact that the insurer doesn’t have a ton of data on the new cannabis industry, makes insurance companies slow in covering cannabis businesses.
The problem with insuring multi-entity cannabis enterprises is that every entity will take different policies, worsening an already shaky situation. The businesses must appear very separate, with different managers and owners.
The cultivation business may require coverage for Goods in Process, Finished Goods, and Outdoor Crops. The dispensary requires coverage for Budtenders, Medical Professional Liability, Supply Chain, Assault and Battery, and General Liability.
When navigating the untested waters of cannabis insurance, separation makes taking covers even more precarious.
The Investment Problem
Separation divides a single entity’s assets into two parts. Establishing multiple entities allows both businesses to seek investments separately. However, both firms can have one manager or owner. If an investor prefers one company over the other, this creates a conflict of interest as jointly managed firms compete against each other.
Of course, creating and implementing cross-company rules can solve this issue. However, the value of the business and even its ROI lowers considerably when cultivation and dispensaries are separate.
The Employee Problem
Even after separation, employees who participate in business strategy continue serving both entities. Without proper employment policies, issues like having a bookkeeper cover a shift in cultivation and dispensary on the same day can cause operational problems.
The simplest solution is to separate employees. However, this idea fails due to issues like the Affordable Care Act, which makes the separated entities an integrated employer. Unless an affiliate business steps in to provide labor to the separate entities, the job problem can remain unsolved.
The Case for Separation
The Liability Advantage
Once growth and dispensaries are separate, each entity becomes a legal person with its liability. Therefore, one business’s legal burden is not another’s liability. If one falls, the other can continue operating. As a cannabis business owner, this protects you against being shut down due to a non-performing entity.
However, managing different entities can create accounting headaches. Cannabis businesses are under tight regulations, and GAAPs may not adequately address the complex structures within which the companies operate. An experienced dispensary accountant can iron this out for you.
The Separation of Funds Advantage
It is common practice to channel funds from one business division to another needy division. Separating growth and dispensaries can solve this problem by ensuring that growth funds stay in growth and dispensary monies remain in retail.
Of course, the division of funds requires discipline. If proper guidelines are unavailable, funds from one entity can spill over to the other. Fund sharing creates massive tax liabilities as the two entities can no longer receive the treatment separate entities receive.
The Sell-Out Advantage
If you cash in on your business, separate entities make your exit strategy easy. Selling an isolated enterprise is much simpler than selling a part of a cannabis company.
The simple argument is that the separate entity has its financial statements filed separately. A clean, neat package with few loose ends and relatively little paperwork can entice investors.
Vertical Integration vs. Separation
With so much information on what to get and what to miss after separating growth from dispensaries, you may wonder which way to go. However, the case for and against separation varies from business to business, as business needs are unique. The solution you should choose is the one that will make the company emerge victorious.
Do you need expert opinion and well-informed cannabis accounting insights about separation? Talk to us about it.